MSI-Transverse deal sparks valuation frenzy in fronting space

Five years after Markel’s $919mn acquisition of State National at 16x 2018 earnings fuelled a surge in start-up activity in the fronting sector, those new entrants are now trying to grasp what Mitsui Sumitomo Insurance Co (MSI)’s surprise $400mn move to buy Transverse means for their own potential valuations.

Only a year after Clear Blue pulled its Evercore-run sales process in August 2021 because private equity bids failed to match expectations on price for the fast-growing firm, the market is scrambling for intel on the Transverse transaction as a read-across for other players in the booming sector.

That includes privately held fronting companies with an eye on a near- to mid-term liquidity event and publicly traded companies assessing whether the equity markets are properly valuing their businesses.

Terms of the transaction have not been disclosed. This publication has verified with sources the initial consideration of $400mn but understands that while there is a meaningful additional earnout in place, the $150mn figure reported is wide of the mark.

The up front price has raised eyebrows in the sector among peers and competitors trying to extrapolate to a multiple of Ebitda – one of the methods used to value fronting carriers (see below).

Growth trajectory

This publication reported in January 2022 that Transverse had grown its book to more than $400mn in annualised premium.

At that level, rudimentary calculations based on a pure fronting model with a 5 percent fee would indicate $20mn of revenue and perhaps $10mn to $12mn of Ebitda based on a margin of 50-60 percent for a carrier in the earlier stages of building out its book.

On the face of it that would indicate an eye-watering multiple of 20x revenue and 33-40x Ebitda – or more than twice what State National was bought for and what Clear Blue was seeking when it came to market last year.

Transverse is not a pure front and claims to be the first of the new breed of players in the space to operate as a hybrid fronting carrier, retaining a percentage of risk on the programs it provides its AM Best A- rated paper to.

Fronting carriers are typically seeking a valuation based on a forward-looking projection of revenue and earnings, although the more they move into the hybrid spectrum, the more a traditional price-to-book valuation might come into play.

Sources have said that Transverse’s rapid growth trajectory means it is on course to go past $800mn in annualised premiums this year as it onboards new programs and grows existing ones.

At that level the metric changes meaningfully. As scale builds at a fronting carrier, margin typically expands, with an Ebitda margin of as high as 80 percent seen as achievable for an operator of significant scale.

Again using what is likely an artificial measure for a hybrid front of 5 percent fees and a conservative margin of 60 percent, revenues of $40mn would translate to Ebitda of $24mn, which in this hypothetical case would extrapolate to a 17x earnings multiple based on the initial consideration, rising higher depending on the level of earnout.

Some sources have questioned that the margin might be significantly lower for a relatively nascent platform that only began onboarding programs in late 2019 and is still in its buildout phase, with 2022 earnings well below our rough calculation based on $800mn of premium.

Another factor is that the 5 percent fronting fee portion of revenue only applies to the business ceded to reinsurers. With Transverse currently retaining up to 10 percent of the programs it fronts, there is also an underwriting income component that could rise on a prospective basis as it retains more risk under MSI ownership.

Bumper year

And arguably in this fast-growing market, a more ambitious forward-looking revenue number for 2023 might be used for the purposes of a valuation exercise, which would bring the multiple down further.

Buoyant conditions in the program sector mean that for most hybrid fronting carriers launched in the last few years 2022 is set to be a bumper year of growth, with no sign of slowing into 2023 and beyond.

The attractive environment is demonstrated by the trajectory of publicly traded companies including R&Q Insurance Holdings and Trisura Group.

R&Q reported earlier this week that its Accredited fronting platform grew gross written premiums (GWP) by 82 percent to $807mn in the first half of 2022, with fee income more than doubling to $39mn.

Meanwhile, Trisura’s US hybrid fronting carrier business saw its GWP jump 77 percent to C$789mn ($617mn), with fee income up by 38 percent to C$29mn in the period.

With most of the 20+ companies now operating some form of pure or hybrid fronting model in the US privately held, up-to-date financials and 2022 growth data are hard to come by.

However, Clear Blue was at the start of the year projecting it would grow written premium from $1.1bn in 2021 to $1.4bn in 2022, a target that may have been raised in the current attractive market environment.

Valuation comparisons

So how would an Ebitda multiple in the mid-teens for Transverse stack up against others in the sector?

Ready comparisons are not easy to make, but Trisura last month raised C$150mn with an equity issue at C$33.25 a share – just under 19x the C$1.77 full-year 2022 earnings consensus forecast of analysts.

US fronting business accounts for more than half of the premium written across Trisura’s carrier platform in North America.

The company is currently trading at 22.3x projected earnings per share and 4.78x book value according to S&P Capital IQ data.

However, if Transverse was valued at a multiple of premium instead – or 0.5x based on estimated 2022 projections of $800mn – it could be argued that R&Q is undervalued in comparison.

Only including R&Q’s fronting business Accredited, GWP is on course to go past the $1.7bn mark this year. At a multiple of 0.5x premium that would suggest a valuation of in the region of $850mn on the business, but R&Q – which also includes an established legacy platform – currently has a market cap of less than half that at just below $400mn.

The price paid for Transverse may also give pause for thought at Hippo over how its acquired in-house fronting business Spinnaker is being valued as part of the insurtech’s overall public market valuation.

Strategic play

Although peers and rivals in the fronting space are likely to be looking at the MSI-Transverse deal from a pricing multiple perspective, sources have said the Japanese buyer is unlikely to have viewed the transaction through that lens.

Instead MSI approached the platform as a strategic acquisition which will allow it to build out its presence in the US and access the fast-growing MGA and programs sector as well as open market business.

It provides it with optionality, with the ability to simply take fronting fees on US programs business or retain a material amount of the risk on its balance sheet.

For Transverse the expected upgrade to A+ in line with its prospective parent would put it out on its own in the fronting segment.

That alone could be a catalyst for more meaningful growth and bigger program relationships, supported by a much larger balance sheet at the group level that could allow it to scale up even more rapidly to respond to opportunities.

“As a buyer MSI is likely to have looked beyond Ebitda multiples and pricing expectations that might have dominated M&A discussions involving a private equity firm, with a longer-term strategic view on the value the platform will bring to the group by providing access to one of the fastest growing areas of the global P&C industry”

The combination also points to an intriguing dynamic for MSI and Transverse, with MS Amlin one of the more active reinsurers in the programs space, potentially playing its part as a strategic supporter of its new fronting carrier stablemate in a market where access to guaranteed reinsurance could be a significant advantage and selling point to MGA partners

And, as reported yesterday, MSI has indicated it will have an appetite for forging strategic relationships with MGAs Transverse fronts for, potentially taking minority investment positions in the future.

All of that means that as a buyer MSI is likely to have looked beyond Ebitda multiples and pricing expectations that might have dominated M&A discussions involving a private equity firm, with a longer-term strategic view on the value the platform will bring to the group by providing access to one of the fastest growing areas of the global P&C industry.

It seems unlikely PE firms would be prepared to come in for other fast-growing privately held fronting carriers at the kind of multiple the Japanese insurer was prepared to pay.

The question is whether other strategic buyers including carriers and distribution platforms eyeing the record growth trajectory in the MGA and programs fronting space will fuel an M&A frenzy among the wave of entrants that followed the Markel-State National deal.